VALUA TION EFFECTS OF OPEN MARKET STOCK REPURCHASES FOR FINANCIALLY WEAK FIRMS George P. Tsetsekos* We test the proposition that announcements of open market stock repurchases improve theflow ofpositive information regarding thefirm's prospects, particularlyfor financially weakfirms. Forfinancially strong firms with already good prospects for cash flows, the role of stock repurchases is less important. We provide evidence for an inverse relationship between financial risk, measured by bond rating, and the magnitude of stock repurchase-induced abnormal returns. Results also suggest that the value of information implied by announcements of open market repurchases about increases in cash flows and leverage, is more important for financially weak firms than for financially strong firms. I. Introduction Stock repurchases are becoming a more common cash distribution mechanism to shareholders, exceeding traditional dividend distributions in aggregate dollar volume. \ Bagwell and Shoven (1989) report that in 1977 the primary mechanism for cash distribu- tions was dividend payments (accounting for 80 percent of the total distributions) while by 1986 common stock repurchases accounted for 60 percent of total cash distributions to shareholders. Open market stock repurchases represent the dominant form of repurchases-approxi- mately 80 percent, according to Tsetsekos, Kaufman and Gitman (1991). Between 1983 and 1986 the number of NYSE firms implementing open market stock repurchases quadrupled (Barclay and Smith, 1989). The frequency and popularity of open market repurchases are not the only interesting aspects of firm payout policy decisions. Voluntary management disclosure of such transactions makes open market repurchases particularly intriguing, especially when managers do not state the reason behind the transaction. This research examines valuation effects of open market stock repurchase announce- ments in terms of the financial health of the firms making the announcements. This examination assumes that an open market repurchase announcement adds to the flow of information about the firm's future prospects. Because perceived cash flow increases and leverage increases are two alternative inferences that can be made from a repurchase announcement, the information content of open market stock repurchases may be different for financially strong and financially weak firms. Given the voluntary disclosure of these transactions, announcements of open market stock repurchases would appear to be relatively more value-enhancing for firms that are perceived to have bleak expectations about cash flows, that is, financially weak firms. Similarly, leverage increases implied by * Department of Finance, College of Business Administration, Drexel University, Philadelphia, PA 19104 (215) 895-1742. I wish to express my thanks and appreciation for helpful comments received on earlier drafts from Mike Gombola and Sam Szewczyk. Also I wish to thank Piyush Mubay and Raj Shah for their computational assistance. I am responsible for any remaining errors.